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Equity Prices Are Artificially High — It’s Time to Take Profits: PIMCO’s El-Erian

Top of the agenda at this week's G20 summit in Moscow: Currency Wars. The G7 put out a statement earlier in the week to dispel fears over competitive devaluations. It ended up sending a muddled message that resulted in more volatility in currency markets.

One constant question in the currency war debate is this: is concern over a new round of currency wars merited? Or are central banks carrying out policy in-line with their mandates, as unconventional as those policies may be (an argument the former chairman of the Swiss National Bank made in the Financial Times)?

Mohamed El-Erian, CEO and co-CIO of PIMCO, which runs the largest bond fund in the world, tells The Daily Ticker it’s both.

“It’s important to understand that,” he says, “because that means it’s not going away, it’s going to get worse.”

El-Erian explains that central banks have been compelled to undertake unconventional measures, things they haven’t done before, because other policymakers are not stepping up to take responsibility on the fiscal side. But central bank activism can be risky. For example, the more liquidity a central bank injects into the financial system, the more likely that nation's currency will drop in value against other currencies. Imports become more expensive in that nation while exports become cheaper. Other nations may take up similar policies in response.

Can this result in beggar-thy-neighbor policies and a "race to the bottom"? El-Erian says yes, but “it can also work.”

Here’s how.

El-Erian asserts that by putting a lot of liquidity into the system and pushing up asset prices, central banks can make us all feel better and this can trigger “wealth effects” – we feel richer and therefore spend more. It can also trigger “animal spirits” – we get all excited and invest more.

The hitch, El-Erian says, is that in the process, central banks may “break” something. A currency war would fall into this camp.

In terms of equity markets, El-Erian says investors are split into two camps. One camp believes that everything will go higher and central banks will succeed in their efforts. The other camp believes asset prices are going to come down to meet the fundamentals.

El-Erian puts himself in the second camp.

“We think that prices are artificially high, that maintaining them here is going to be hard as central banks become less effective, and that it’s time to book some profits and to wait for some better entry points,” he explains.

He clarifies that this is not a “Lehman moment." But “prices that have gotten way ahead of what policy can deliver," he declares.